Spain Still Vulnerable Despite $125 Billion Bailout

Spain is still vulnerable after its mega bank bailout. Madrid has finally got a credible plan for its lenders: it will receive up to 100 billion euros ($125 billion) from its euro partners to boost their capital. But the state's debt will rise as a result, the economy is still shrinking and the government has lost a lot of credibility. Spain may yet require a full bailout. That would really test the single currency.

The 100 billion euro figure is at the top end of most analyst estimates, and more than double the 40 billion euros that the International Monetary Fund had estimated the banks needed.

It should go a long way towards reassuring investors that Spanish lenders are sufficiently capitalized to withstand shocks. It should also reduce the risk of a bank run if there is trouble following next Sunday's Greek elections. It may even help limit a severe credit crunch.

If Mariano Rajoy's conservative government had taken this bull by the horns soon after it took office in December, that might have been the end of the matter. It could have blamed the bailout on the previous socialist administration. Unfortunately, it wasted six months dragging its feet on the problem, with two incomplete financial reforms. In the process, market confidence has been knocked. And Rajoy's own credibility both at home and abroad has suffered.

Fortunately, Rajoy still has a solid majority and three and a half more years before he has to face an election. The best he can now do is take the brickbats and press ahead rapidly — both with the recapitalization of the banks and the further economic reforms, where he has actually been quite decisive.

On the former front, it is slightly worrying that the government is talking about giving lenders some more time to raise capital themselves rather than take state cash. If there is any further time, it should be very short. It would be a mistake to let this drag on any longer.

The bank bailout could add up to 10 percentage points to Spain's debt ratio. Even then, it should peak at about 100 percent of GDP in 2015. That's high but a lot less than Italy, whose debt is over 120 percent of GDP. A big difference, though, is that Spain has been running a large current account deficit for years and so is heavily dependent on foreign finance, even if the gap is shrinking.

Some details of the bailout are not clear. One is whether the loan would be senior to Madrid's existing debt. If so, that could make it hard for Spain to sell any new bonds. Even if that's not the case, investors will be put off by an economy that is expected to shrink this year and next — as well as possible further downgrades in its credit rating. If Greece were then to quit the euro, Madrid could be shut out of the market.

The question then would be what to do. Spain would probably want the European Central Bank to buy its bonds in the market. But the central bank would be wary of doing that. The alternative would be a full bailout for the country. But it's not clear whether the eurozone funds have enough money to finance that. They certainly wouldn't if Italy also got dragged into the vortex.

Any relief provided by Spain's bank bailout could be short-lived.

CONTEXT NEWS

• Eurozone finance ministers have agreed to lend Spain up to 100 billion euros to recapitalize its banking sector, with no new fiscal austerity demands but subject to further reforms in the financial sector.

• Luis de Guindos, Spain's economy minister, said the request for funds was in no way a rescue. "It's a loan with very favorable conditions."

• De Guindos said the government would specify the amounts needed after two independent consultancies — Oliver Wyman and Roland Berger — deliver their assessment of the banking sector's capital needs some time before June 21.

• In a statement, the Eurogroup said the "loan amount must cover estimated capital requirements with an additional safety margin." The loans will be channeled through Spain's bank restructuring fund, the Frob. The Eurogroup did not specify whether the money would come from the current rescue fund, the European Financial Stability Facility, or the European Stability Mechanism, due to come into force in July.

• Madrid said the funds had little conditionality and would be disbursed on more favorable terms than current market rates.

• The Eurogroup said the loan conditions "should be focused on specific reforms targeting the financial sector, including restructuring plans in line with EU state-aid rules and horizontal structural reforms of the domestic financial sector." It invited the IMF, which will not be providing any money to Spain, to support the implementation and monitoring of the financial assistance with regular reporting.

• The Eurogroup added that Spain had already implemented significant labor and fiscal reforms and was confident that it would honor its commitments to continue correcting its macroeconomic imbalances. Progress would be closely and regularly reviewed.